Gazprom Finally Accepts that Shale Gas Has Changed the World

The Russian gas giant this week said it will allow up to 15% of its gas sales to Europe to be sold at spot gas prices on the continent.

This is a big shift for Gazprom. Previously, the major insisted on selling gas to European users under long-term contracts. With gas prices linked to prevailing oil prices.

It's long been usual practice in Europe to sell gas using an oil-linked price structure. Decades ago, when gas was just coming into widespread use, players in the industry decided that the fuel should be priced according to value of the other fuels it was displacing. If users were switching from oil to gas, the gas should cost roughly as much as the unused oil, on an energy-content basis.

This cost structure prevailed in Europe for a long time. But shale gas seems to have cut the legs out from under oily gas prices.

With America now producing above and beyond expectations thanks to shale gas development, gas exporters globally are scrambling to find markets. The world built liquefied natural gas plants thinking the U.S. would be the "market of last resort".

But America is awash in its own production, and the high American prices that exporters were hoping for have vanished. Meaning that today there is a fleet of LNG ships looking for a home for their product.

This flood of global gas supply has depressed spot gas prices globally. To the point where the traditional 6 to 1 oil to gas price ratio has become more like 15 to 1. Gas is very cheap compared to crude.

The result being that European gas users would rather buy cheap LNG than pay high rates for oil-linked gas piped in by Gazprom.

Gazprom resisted re-pricing its gas for some time. But this week's announcement suggests the company has finally capitulated. They are willing to sell some of their gas at lower, spot prices. Otherwise they will be largely priced out of the European market.

The interesting thing will be the knock-on effects of Gazprom's decision. Suddenly, a lot of Russian gas is price-competitive with LNG. Meaning that fewer LNG shipments will be ordered to the continent.

The question is: where will these boats go? They may end up headed back to America. Asian gas buyers are busy sewing up contracts with new LNG developments in Australia. If Europe and Asia are out, the U.S. is the only game in town.

A spate of new LNG landings in the U.S. would have a downward effect on North American gas prices. At a time when prices in many parts of America are already falling below $5 per mcf. Just this week, gas major EnCana said it expects North American prices to remain in the $6 range for the foreseeable future.

This is progress. The gas industry did a great job over the last several years of developing new supply globally. Now we just have to find a place to put it all.

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